The constitutional validity of Insolvency and Bankruptcy Code, 2016 upheld

Swiss Ribbons Pvt. Lmt. V. Union of India

2019 SCC OnLine SC 73

WRIT PETITION (CIVIL) NO. 99 OF 2018 decided on 25.01.2019

Bench

RF Nariman and Navin Sinha, JJ 

Issue

Constitutional validity of the Insolvency and Bankruptcy Code, 2016?

Held

The Supreme Court upheld the validity of the Insolvency and Bankruptcy Code, 2016 in its entirety. 

Summary

Question of law

Whether the appointment of members of the NCLT and the NCLAT not contrary to this court’s in Madras Bar Association (I & II)  judgments?

Argument Advance

Petitioner

Respondent

It was argued that the members of the National Company Law Tribunal [NCLT] and certain members of the National Company Law Appellate Tribunal[NCLAT] apart from the President have been appointed contrary to this Court‘s judgment in Madras Bar Association v. Union of India, (2015) 8 SCC 583 and that therefore, this being so, all orders that are passed by such members, being passed contrary to the judgment of this Court in the aforesaid case, ought to be set aside.

In any case, until a properly constituted committee, in accordance with the aforesaid judgment, reappoints them, they ought not to be allowed to function.

The Respondent argued that none of the members of the NCLT or the NCLAT had been appointed contrary to the judgments of this Court in Union of India v. R. Gandhi, President, Madras Bar Association (2010) 11 SCC 1 and Madras Bar Association v. Union of India, (2015) 8 SCC 583.

They referred to affidavits filed before this Court to show that all such members had been appointed by a Committee consisting of two Supreme Court Judges and two bureaucrats, in conformity with the aforesaid judgments.

Held

The Court said that acting in compliance with the directions of the Supreme Court in the aforesaid judgments, a Selection Committee was constituted to make appointments of Members of the NCLT in the year 2015 itself. Thus, by an Order dated 27.07.2015, (i) Justice Gogoi (as he then was), (ii) Justice Ramana, (iii) Secretary, Department of Legal Affairs, Ministry of Law and Justice, and (iv) Secretary, Corporate Affairs, were constituted as the Selection Committee. This Selection Committee was reconstituted on 22.02.2017 to make further appointments. In compliance of the directions of this Court, advertisements dated 10.08.2015 were issued inviting applications for Judicial and Technical Members as a result of which, all the present Members of the NCLT  and NCLAT have been appointed.

Question of law

Regarding NCLAT bench only at Delhi.

Argument Advance

Petitioner

The Petitioner argued that if the powers of the High Court are taken away, the NCLAT, as an appellate forum, should have the same convenience and expediency as existed prior to appeals going to the NCLAT. Since the NCLAT, as an appellate court, has a seat only at New Delhi, this would render the remedy inefficacious inasmuch as persons would have to travel from Tamil Nadu, Calcutta, and Bombay to New Delhi, whereas earlier, they could have approached the respective High Courts in their States.

This again is directly contrary to Madras Bar Association v. Union of India, (2014) 10 SCC 1 and to paragraph 123 in particular.

Judgment

The Court directs the Union of India to set up Circuit Benches of the NCLAT within a period of 6 months from today.

Question of law

Regarding the tribunals are functioning under the wrong ministry.

Argument Advance

Petitioner

Respondent

It was argued that the administrative support for all tribunals should be from the Ministry of Law and Justice.

However, even today, NCLT and NCLAT are functioning under the Ministry of Corporate Affairs. This again needs to be corrected immediately.

It was pointed out Article 77(3) of the Constitution of India and Delhi International Airport Limited v. International Lease Finance Corporation and Ors., (2015) 8 SCC 446, which state that once rules of business are allocated among various Ministries, such allocation is mandatory in nature. Therefore, the rules of business, having allocated matters which arise under the Insolvency Code to the Ministry of Corporate Affairs, are mandatory in nature and have to be followed.

Judgment

The Court held that the rules of business, being mandatory in nature, and having to be followed, are to be so followed by the executive branch of the Government. Further, the Court said that the Bench is bound by the Constitution Bench judgment in Union of India v. R. Gandhi, President, Madras Bar Association (2010) 11 SCC 1 . This statement of the law has been made eight years ago. It is high time that the Union of India follow, both in letter and spirit, the judgment of this Court.

Question of law

Whether classification between financial creditor and operational creditor is discriminatory, arbitrary or  violative  of Art. 14 of the Constitution of India?

Argument Advance

Petitioner

Respondent

The submission of the petitioners in this behalf is that the legislative scheme that is contained in Section 7 of the Code, stating that there is no real difference between financial creditors and operational creditors is violative of Art 14. According to him, both types of creditors would give either money in terms of loans or money‘s worth in terms of goods and services. Thus, there is no intelligible differentia between the two types of creditors, regard being had to the object sought to be achieved by the Code, namely, insolvency resolution, and if that is not possible, then ultimately, liquidation. Relying upon Shayara Bano v. Union of India, (2017) 9 SCC 1 it was argued that such classification will not only be discriminatory, but also manifestly arbitrary, as under Sections 8 and 9 of the Code, an operational debtor is not only given notice of default, but is entitled to dispute the genuineness of the claim.

In the case of a financial debtor, on the other hand, no notice is given and the financial debtor is not entitled to dispute the claim of the financial creditor. It is enough that a default as defined occurs, after which, even if the claim is disputed and even if there be a set-off and counterclaim, yet, the Code gets triggered at the behest of a financial creditor, without the corporate debtor being able to justify the fact that a genuine dispute is raised, which ought to be left for adjudication before ordinary courts and/or tribunals.

It was submitted that when it came to classification between financial and operational creditors, they argued that the differentiation between the two types of creditors occurs from the nature of the contracts entered into with them. Financial contracts involve large sums of money given by fewer persons, whereas operational creditors are much larger in number and the quantum of dues is generally small.

Financial creditors have specified repayment schedules and agreements which entitle such creditors to recall the loan in totality on defaults being made, which the operational creditors do not have.

Further, financial creditors are, from the start, involved with the assessment of viability of corporate debtors and are, therefore, better equipped to engage in restructuring of loans as well as reorganization of the corporate debtor‘s business in the event of financial stress.

 All these differentiae are not only intelligible, but directly relate to the objects sought to be achieved by the Code.

Judgement

The Court held that financial creditors are involved with assessing the viability of the corporate debtor. They can, and therefore do, engage in restructuring of the loan as well as reorganization of the corporate debtor’s business when there is financial stress, which are things operational creditors do not and cannot do. Thus, preserving the corporate debtor as a going concern, while ensuring maximum recovery for all creditors being the objective of the Code, financial creditors are clearly different from operational creditors and therefore, there is obviously an intelligible differentia between the two which has a direct relation to the objects sought to be achieved by the Code.

The Court further elaborated the difference between financial creditor and operational creditor which is as follows:

Financial Creditor

Operational Creditor

Most financial creditors, particularly banks and financial institutions, are secured creditors

Most operational creditors are unsecured, payments for goods and services as well as payments to workers not being secured by mortgaged documents and the like

Financial creditors generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business

Contracts with operational creditors are relatable to supply of goods and services in the operation of business.

Financial contracts generally involve large sums of money

Operational contracts have dues whose quantum is generally less.

Financial creditors have specified repayment schedules, and defaults entitle financial creditors to recall a loan in totality

Contracts with operational creditors do not have any such stipulations.

Financial creditors are, from the very beginning, involved with assessing the viability of the corporate debtor. They can, and therefore do, engage in restructuring of the loan as well as reorganization of the corporate debtor‘s business when there is financial stress.

Operational creditors do not and cannot do any of these things

Financial contracts generally involve large sums of money

Operational contracts have dues whose quantum is generally less.

Question of law

Whether Section 12A is not violative of article 14?

[S 12-A. Withdrawal of application admitted under Section 7, 9 or 10.—The Adjudicating Authority may allow the withdrawal of application admitted under Section 7 or Section 9 or Section 10, on an application made by the applicant with the approval of ninety per cent voting share of the committee of creditors, in such manner as may be specified.]

Argument Advance

Petitioner

Respondent

It is submitted that Section 12A of the Code is contrary to the directions of this Court in its order in Uttara Foods and Feeds Pvt. Ltd. v. Mona Pharmachem, Civil Appeal No. 18520/2017 [decided on 13.11.2017], and that instead of following the said order, Section 12A now derails the settlement process by requiring the approval of at least ninety per cent of the voting share of the committee 6 of creditors. Unbridled and uncanalized power is given to the committee of creditors to reject legitimate settlements entered into between creditors and the corporate debtors.

The Respondent submitted insofar as Section 12A is concerned, they argued that once an application by a creditor is admitted by the Adjudicating Authority, the proceeding becomes a proceeding in rem and is no longer an individual proceeding but a collective proceeding. This being the case, it is important that when a resolution process is to begin and a committee of creditors is formed, it is that committee that is best equipped to deal with applications for withdrawal or settlement after admission of an insolvency petition. Ninety per cent of such creditors have been given this task as once the proceeding is in rem, to halt 13 such proceeding, which is for the benefit of all creditors generally, can only be if all or most of them agree to the same.

It was argued further that argued that the resolution professional has no adjudicatory powers under the Code or the Regulations, but is only to collate information.

Judgement

The Court saying that Section 12A also passes constitutional muster held that once the Code gets triggered by admission of a creditor‘s petition under Sections 7 to 9, the proceeding that is before the Adjudicating Authority, being a collective proceeding, is a proceeding in rem. Being a proceeding in rem, it is necessary that the body which is to oversee the resolution process must be consulted before any individual corporate debtor is allowed to settle its claim.

A question arises as to what is to happen before a committee of creditors is constituted (as per the timelines that are specified, a committee of creditors can be appointed at any time within 30 days from the date of 101 appointment of the interim resolution professional).

The Court makes it clear that at any stage where the committee of creditors is not yet constituted, a party can approach the NCLT directly, which Tribunal may, in exercise of its inherent powers under Rule 11 of the NCLT Rules, 2016, allow or disallow an application for withdrawal or settlement. This will be decided after hearing all the concerned parties and considering all relevant factors on the facts of each case.

The main thrust against the provision of Section 12A is the fact that ninety per cent of the committee of creditors has to allow withdrawal. This high threshold has been explained in the ILC Report as all financial creditors have to put their heads together to allow such withdrawal as, ordinarily, an omnibus settlement involving all creditors ought, ideally, to be entered into. This explains why ninety per cent, which is substantially all the financial creditors, have to grant their approval to an individual withdrawal or settlement. In any case, the figure of ninety per cent, in the absence of anything further to show that it is arbitrary, must pertain to the domain of legislative policy, which has been explained by the Report (supra). Also, it is clear, that under Section 60 of the Code, the committee of creditors do not have the last word on the subject. If the committee of creditors arbitrarily rejects a just settlement and/or withdrawal claim, the NCLT, and thereafter, the NCLAT can always set aside such decision under Section 60 of the Code.

Question of law

Constitutional validity of section 29A?

[Section 29A provides ineligibility of a person to be resolution applicant]

Argument Advance

Petitioner

Respondent

The argument was raised against Section 29A, in particular, clause (c) thereof is that the vested rights of erstwhile promoters to participate in the recovery process of a corporate debtor have been impaired by retrospective application of Section 29A.

Section 29A, in any case, is contrary to the object sought to be achieved by the Code, in particular, speedy disposal of the resolution process as it will inevitably lead to challenges before the Adjudicating Authority and Appellate Authority, which will slow down and delay the insolvency resolution process. In particular, so far as Section 29A(c) is concerned, a blanket ban on participation of all promoters of corporate debtors, without any mechanism to weed out those who are unscrupulous and have brought the company to the ground, as against persons who are efficient managers, but who have not been able to pay their debts due to various other reasons, would not only be manifestly arbitrary, but also be treating unequals as equals.

It was also argued that maximization of value of assets is an important goal to be achieved in the resolution process. Section 29A is contrary to such goal as an erstwhile promoter, who may outbid all other applicants and may have the best resolution plan, would be kept out at the threshold, thereby impairing the object of maximization of value of assets. Another argument that was made was that under Section 29A(c), a person‘s account may be classified as a nonperforming asset in accordance with the guidelines of the Reserve Bank of India despite him not being a wilful defaulter. Also, the period of one year referred to in clause (c) is again wholly arbitrary and without any basis either in rationality or in law.

It was argued that Section 29A does not disturb any vested or existing rights, as a resolution applicant does not have any vested or existing rights that can be disturbed, as has been held in ArcelorMittal India Private Limited v. Satish Kumar Gupta and Ors., Civil Appeal Nos. 9402-9405/2018 [decided on 04.10.2018].

Further, merely because this Section relies on antecedent facts for its application, does not mean that it is retrospective.

Also, Section 29A subserves a very important object of the Code, which is to see that undesirable persons who are mentioned in all its clauses are rendered ineligible to submit resolution plans so that such persons may not come into the management of stressed corporate debtors.

It is also argued that Section 29A is not aimed at only persons who have committed acts of malfeasance, but also persons who are otherwise unfit to be put in the saddle of the management of the corporate debtor, such as undischarged insolvents and persons who have been removed as directors under Section 164 of the Companies Act, 2013 (for not filing financial statements or annual returns for any continuous period of 3 financial years, for example). They further argued that a period of one year is sufficient period within which a person, whose account has been declared NPA, should clear its dues. They referred to the RBI Regulations dealing with NPAs and stated that even before a person‘s account is declared NPA, a long rope is given for such person to clear off its debts. It is only when it does not do so, that its account is declared NPA in the first instance. Also, once the said guidelines are perused, it is clear that an account, which has been NPA for one year, is declared as substandard asset and it is for this reason that the one year period is given in Section 29A(c), which is based on reason, and is not arbitrary.

Judgement

The Court upheld the constitutional validity of S. 29A of the Code.